Balkrishna's valuation premium over tyre peers likely to deflate
Balkrishna Industries, an exporter of offhighway tyres, enjoys a valuation premium to conventional tyre-makers. That premium could narrow as global demand moderates, slowing earnings growth.
Balkrishna trades at 18.5 times one-year forward earnings, a premium of about 43% compared with peers in the conventional tyre market. Historically, Balkrishna enjoyed the premium due to superior operating margins, stable volume growth and increasing market share overseas.
The application of off-highway tyres is in the agricultural and mining sectors. Balkrishna derives nearly 60% of volume from the agriculture sector and 36% from the mining sector.
A large chunk of its volume is derived from the replacement market in Europe and the US, which together account for 66-67% of the total volumes for the company. Demand for agricultural tyres dropped in Europe due to drought in the region and tariffs imposed on soybean, wheat, and corn by the Chinese government. Farm bankruptcies in the US increased significantly in the Mid-Western states.
Volumes dropped 9.6% in the June quarter, and the agricultural segment volume slipped 13%. This is a reflection of the pressure on farm income. Similarly, the off-the-road (OTR) volume has been shrinking due to falling commodity prices, which have moderated capital expenditure of the mining companies globally.
Balkrishna has projected 3-4% volume growth for the current fiscal. It appears to be a tough task given the demand moderation. In the past five years, volumes grew 8% annually, while industry growth has been listless. Besides, several global tyre makers have acquired companies in the emerging markets, such as Mitas and Camso, blunting Balkrishna's cost edge. The Street has to start pricing volume growth of 1-2% for the current fiscal year.
Low volume growth has heightened competitive intensity, and expansion plans could weigh on the margins. Operating margins fell 480 basis points to 24.3% in the June quarter. On an average, the margins have been 29.3% in the past three fiscal years.